In the next crucial decade, huge investment is required to accelerate the transition to net zero in line with the goals of the Paris Agreement. The UK government is currently carrying out a Transition Finance Market Review (TFMR) to consider how the UK can become a leading hub for and provider of transitional financial services, with findings due to be published later this year. As the TFMR Call for Evidence noted, £50-60 billion of investment per year will be needed in the UK alone by the late 2020s and early 2030s. The UK is uniquely placed to shape the emerging transition finance market standards, given London’s position as a leading global financial sector, and such standards could support plugging the transition finance investment gap.

Transition finance challenge and opportunities

The UK government should have a joined-up approach to considering how the UK can ensure that it delivers on its net zero commitments whilst maximising the economic opportunities created. Policies and partnerships are critical to the deployment of transition-enabling technologies and to de-risking private investment for hard-to-abate sectors. These can be complemented by strong financial sector frameworks and policies that support the financial sector in aligning its activities to the net zero transition.

In this context, a transition finance market framework can be an important part of an overall package of policies and regulations to decarbonise the economy in line with the UK’s net zero commitments. There are now thriving green finance and sustainability-linked markets underpinned by standards set by institutions like the International Capital Markets Association and the Climate Bonds Initiative. The transition finance market has not yet flourished in the same way, in part because there is little consensus on definitions for transition finance globally and investors are concerned about greenwashing. Establishing frameworks to make transition finance more transparent and accessible is crucial to support the transition of hard-to-abate and highly emitting sectors on the path to zero emissions.

The UK has already shown strong global thought leadership on the development of transition planning standards via the UK’s Transition Planning Taskforce and this work could be a natural extension to that.

Strategic aims of the UK’s TFMR

The stated objectives of the TFMR include scaling transition-focussed capital raising with integrity and positioning the UK’s professional services ecosystem as a global hub. However, the objectives as articulated do not adequately recognise the reason that the transition finance market needs to be created in the first place – to support financing the decarbonisation of the real economy in line with the Paris Agreement.

Unless the review is centred on creating a transition finance market that supports the UK meeting its net zero obligations, the recommendations that emerge from the review will fail to deliver on that goal. The UK TFMR should adopt the following strategic aims:

• Limit warming in line with the Paris Agreement to avoid severe and potentially irreversible effects of climate change.
• Channel transition finance to decarbonising high-emitting and/or hard-to-abate sectors, particularly over the next crucial decade – reducing the cost of capital as the market rewards investment now that reduces risk later.
• Invest capital in a way that supports the just transition and safeguards nature and biodiversity.

Market integrity and guardrails

The emphasis that the Call for Evidence places on building a transition finance market with credibility and integrity is welcome. Market integrity is created by establishing strong guidelines and standards for market participants.

The Call for Evidence’s starting point is to take a broad approach to definitions, incorporating all types of economic activity and all types of financing. By failing to distinguish between green financing and transition financing, though, there is a risk that insufficient focus is placed on the decarbonisation of high-emitting and hard-to-abate sectors. This approach also risks transition finance becoming a label for business-as-usual financing that contributes to extending the lifetime of high-emission assets and technologies.

We therefore urge the UK TFMR secretariat to set clear principles for the scope of transition finance by answering the following questions:

• Which sectors have credible, Paris Agreement-aligned sectoral decarbonisation pathways available for transition finance?
• How should financial institutions assess which entities have credible Paris Agreement-aligned transition plans in the absence of an institutional architecture that provides an independent view of credibility?
• Which activities qualify as transition finance-related?
• What are the relevant time horizons to avoid carbon lock-in and ensure that this is not business-as-usual financing that extends the lifetime of high emission assets, pathways, and technologies?

It is important to have clarity on how transition finance might apply to different types of financial products and services. For example, with appropriate guardrails, it should be possible to issue use-of-proceeds transition bonds with well-defined targets and goals even to companies that lack a comprehensive transition plan.

The UK TFMR Secretariat has an opportunity to develop strong market standards to channel private finance towards the decarbonisation of hard-to-abate and high-emitting sectors during the crucial next decade. Clear principles and guardrails can build credibility and integrity into the market to avoid greenwashing and support real world decarbonisation.